Banks Ready to Use Low-Quality Collateral If It’s Cheap

By Nandini Sukumar -
Jul 22, 2013

One in three financial institutions
would accept “low-quality, complex and opaque” collateral to
back trades provided that it’s “cheap,” according to a survey
from the operator of Switzerland’s exchange and clearinghouse.

More than half -- 57 percent -- of the 60 industry
participants surveyed on behalf of SIX Group said that the cost
of collateral was more important than its quality. About 48
percent of the respondents answered that securitizing and
repackaging existing securities to create pools of collateral
would increase risk, possible leading to another financial
crisis. Some 43 percent said they wanted “simple, high quality,
liquid and easy to value” collateral, the survey found.

“It is a frightening prospect that in today’s market,
over a third of financial institutions are willing to accept
collateral simply because it is cheap,” said Robert Almanas,
managing director for international services at SIX Securities
Services. “When our competition begins to compete on the
quality of collateral they are prepared to take, the ‘race to
the bottom’ becomes a very real outcome.”

Institutions may need as much as $6.7 trillion in
additional collateral to satisfy new bank capital rules and
swaps-clearing mandates, securities-industry consultancy
Finadium LLC said in December. The lack of cost-effective assets
to back swaps trades has prompted some market users to exchange
lower-rated securities for cash or highly rated securities, the
Concord, Massachusetts-based firm specializing in securities
lending and collateral management said. It described the
practice as collateral transformation.

The U.S. Dodd-Frank Act, the Basel III accords and the
European Market Infrastructure Regulation initiative will drive
more swap trades through clearinghouses. Financial institutions
will have to seek different sources of collateral because
clearinghouses require upfront collateral. CME Clearing Europe
now accepts physical gold as collateral, extending the list of
assets it’s prepared to receive.

Vanson Bourne conducted the survey on SIX Group’s behalf in
December, interviewing industry participants in the U.K., France
and Germany.